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The government says Europe’s ETS offers the cheapest way of achieving its goal of reducing global emissions by the equivalent of a 5 per cent cut to Australian emissions by 2020.

But it did not seem to appreciate that an ETS relies on an artificial market created by governments to trade a synthetic financial product called an emissions permit (or allowance or carbon credit) whose price is inherently volatile.

While economic growth and emissions remain low in Europe, a low price will be enough to stay within its regulated cap on emissions. But many analysts doubt the scheme will cut overall emissions by 2020.

The current budget’s projected $6.7 billion of emissions revenue in 2015 is based on Treasury’s forecast EU price of $29 per tonne in 2015.

The December 2013 price in the EU futures market is around $4 a tonne compared with about $6.50 for December 2012. There is scant chance it will reach $29.

Even if the EU price more than doubles to $10 in 2015, revenue will only be $2.3 billion. This will not cover half Labor’s cost of over $4.8 billion to compensate households in 2015, before other costs are included.

Gillard insists she will not cut household compensation – mainly via the welfare and tax systems – no matter how much revenue falls. The Coalition says it won’t either, although it won’t have any carbon revenue.

The $23 a tonne carbon tax has increased the CPI by 0.7 per cent, but the government deliberately overcompensated age pensioners and self-funded retirees for a 1.7 per cent increase. Family payments also rose by 1.7 per cent, enough to cover a $56 carbon tax.

Letting normal CPI indexation apply would have been sufficient, especially as the price impact after July 2015 could easily be under 0.3 per cent. The household compensation also included a lift in the tax-free threshold from $6000 to $18,200.

The government paid for part of the cost by increasing the 15 per cent marginal tax rate to 19 per cent and the 30 per cent rate tax rate to 32.5 per cent. These increases, plus a big cut to the low income tax offset, reduced the net cost of the higher threshold to about $10 billion over four years.

However, the $23 a tonne carbon tax won’t be enough to cover the shortfall, let alone a price of $4 or the Coalition’s zero.

Labor gave brown-coal-fired generators $1 billion before the carbon tax began in July 2012. Another $4.5 billion was due to follow, but it was in free emissions permits that now look less costly.

The $1 billion was supposed to be an initial tranche of compensation for the generators’ presumed loss in asset values. But there will be no loss if the Coalition wins the election and scraps the tax. If Labor wins, brown coal generators’ costs will remain well below competing technologies, even with an implausible emissions price of well over $30.

It is now clear that politicians will not let a carbon price go high enough to induce a switch to low-cost, low-emissions technologies that are essential to an economically efficient cut to emissions without a damaging recession.

The Danish analyst
Bjørn Lomborg
makes a strong case that the key to cutting emissions is a large international effort to develop technologies that produce much cheaper and cleaner energy.

The necessary funding should only require a modest carbon levy, or none if fossil fuel subsidies are scrapped.

However, the Gillard government devoted almost none of its carbon tax revenue for this purpose. Instead, it has squandered a lot more than the available revenue on massively over-compensating people and firms addicted to government handouts.